Friday, June 29, 2012

Leo de Bever Warns of Storm Clouds Ahead?

Gary Lamphier of the Edmonton journal reports, AIMCo boss warns of storm clouds ahead for financial markets:
I wouldn’t want Leo de Bever’s job.

Oh sure, it pays well. And as CEO of Edmonton-based Alberta Investment Management Corp. (AIMCo) you get to play with real money.

We’re talking nearly $70 billion of public sector pension, endowment and government financial assets.

Running a pile that big must be quite a rush — on a good day, anyway. On a bad day? Not so much.

Alas, the global economy and world equity markets have endured more than a few bad days lately, with many more to come.

When your portfolio can rise or fall by as much as $300 million by supper time, it requires someone with ice in his veins to manage it.

De Bever certainly qualifies, and that’s a key reason why AIMCo managed to post a healthy 7.4 per cent net return on assets for the fiscal year ended March 31.

Thanks to big gains in real estate (22.8 per cent), real return bonds (16.3 per cent) and private equity (13.1 per cent), AIMCo overcame a perfectly lousy year for stocks.

The provincial Crown corporation’s Canadian equity holdings slid by 6.9 per cent — reflecting a decline in the overall market — and its global equities rose a modest 4.7 per cent.

Despite the turmoil in stock markets, AIMCo topped most of the benchmarks against which it measures its performance. But de Bever was in no mood to gloat Wednesday as AIMCo released its 2011-2012 annual report.

With Europe’s festering sovereign debt crisis far from resolved and the U.S. economy slowing, the future looks anything but clear.

“As much as I’m proud of what we did last year in a bad market, I’m nervous about what’s coming,” says de Bever.

“Right now we’ve put our clients on notice that in the next year or two we may have one of those episodes like we had in 1987, where you had a quick changing of gears in markets. We’re trying desperately to make sure that we’re ready for that.”

De Bever’s big worry is that the 30-year-old bull market in bonds is ending. Yet it’s impossible to predict the timing of the event perfectly. Much will depend on how governments in Europe and the U.S. ultimately deal with their massive debts, and when interest rates start to rise.

In his view, German Chancellor Angela Merkel’s austerity approach is the wrong way to go, but it may take another couple of years before Europe moves to boost its recession-bound economies.

“We’re having very low GDP growth and the reason for that is that governments are frugal, individuals are frugal, and in economics that leads to something called the paradox of thrift,” he says.

“Everybody is frugal because it’s in their own best interests, but collectively that makes demand less than supply, so you have very high unemployment. In a lot of European countries youth unemployment is in the 30 to 40 per cent range. What that tells me is that the policy of austerity isn’t working,” he adds.

“But the politics around it in the U.S. and in Europe are so awful that it’s not changing. The austerity mantra is still there, and the way I like to express it is, austerity is great for the soul, but it’s not so great for the economy. So that’s the dilemma.”

Eventually, governments will ditch the austerity approach and move to “reflate” their economies rather than face outright default on their debt, de Bever believes.

“One way they’re likely to do that is to promote more government investment, particularly in the infrastructure area. Everybody is talking about that but nobody is doing anything. But my guess is, sometime in the next year that’s going to start to happen. Hopefully that will make GDP growth a little stronger, and when that happens interest rates should start to firm.”

When the move does happen, de Bever vows that AIMCo will be ready to jump in, since it regards public infrastructure as an attractive alternative to bonds in the years ahead. Still, he admits he’s frustrated by the dearth of suitable investment opportunities right now.

“I was in the U.K. three weeks ago talking to the Lord Mayor of London. The U.K. had come to Edmonton, believe it or not, to encourage us to put more money into U.K. infrastructure. So then I go and say ‘OK, I’m here. Where are the projects?’ And there’s nothing there. You find that all over the place.”

I will cover AIMCo's fiscal 2012 results in detail next week. Those of you who want to read their annual report can do so by clicking here. It's excellent, full of detailed information.

Leo de Bever is one of the smartest investment managers in the world. If you ever sat with him one on one or in a group meeting, you'd know exactly what I'm talking about. Extremely well read, understands all sources of risk in public and private markets, and is able to synthesize these risks to understand sources of systemic risk for overall market.

In early May, he appeared on CNBC, calling the top on bonds. His timing was a bit off because Treasuries continued to rally to new record lows as euro woes and Greek elections caused a massive flight to safety, but to be fair, he said it was "near" and he didn't know exactly when.

Global pension funds should take heed of de Bever's ominous warning. Their flight to safety has skewed the market as many of them are unable to cope in these volatile, rigged markets dominated by high frequency algos trading macro news out of Europe and elsewhere.

As for paradox of thrift, a topic I covered exactly two years ago warning it will pound pensions, he's absolutely right that Merkel's austerity measures aren't working and that governments around the world adopting such measures will face increasing political pressure to reverse course and reflate their economies, focusing primarily on growth and job creation, not cutting deficits.

Reuters reports that leaders agreed on Friday to bend their aid rules to shore up banks and bring down the borrowing costs of stricken members like Italy and Spain, in a sign the bloc is adopting a more flexible approach to solving its two-year old debt crisis.

As I stated many times, the power elite will do everything they can to thwart a protracted period of global deflation. Those of you who don't understand this will never make money in these volatile markets.

Is Leo de Bever right to warn of storm clouds ahead? Yes, he's right because when yield thirsting pensions start collectively shifting out of bonds into stocks again, and central banks start reining their liquidity, the disruption can mean a major backup in bond yields. When that happens, it could spell chaos for markets.

The good news is we don't have to worry about that yet. I see a major summer rally on its way. Below, de Bever's CNBC interview done in early May. Also embedded a Bloomberg interview with
Philadelphia Trust Co.'s President and CEO Michael Crofton discussing the European debt crisis. He thinks the response from European leaders wasn't good enough as they need more money and more clarity.

Thursday, June 28, 2012

Beware of Currency Managers?

Chris Tobe of Stable Value Consultants sent me a guest comment, Beware of Currency Managers at Public Pensions Plans:
Public Pensions nationwide need to think long and hard before they hire a currency manager. As an investment consultant and trustee I had never heard of a public pension plan using an active currency manager.

In August 2011 in my role on the investment committee I noticed that the performance of the $12 billion Kentucky Retirement Systems (KRS) for the June 2011 fiscal year looked odd. I noticed that we trailed our overall benchmark 160bps or $250 million, while all the individual money managers all beat their benchmarks for the year. I asked our CIO to explain and told me that over $100 million of this loss was due to a currency manager (Record) I was not aware of (see here).

After this discovery I inquired from our investment consultant their views on currency managers. RV Kuhns did not think Currency Overlay managers were appropriate for Public Pension Plans. The reasoning behind this is that Public Plans buy international stocks because they move differently than domestic stocks and part of this is currency. Our international stock benchmark is not hedged so we do not need to or want to hedge.

Record was never mentioned at any of the investment committee meetings I attended until I discovered their existence in August 2011. Record as a manager was not in Investment reports from August 2009 to Aug 2011. When finally disclosed it was the first time that I had ever seen a negative balance reported for a manager with a negative -$27 million in the pension and a -$10 million in insurance funds (see here).

Not only was RV Kuhns not aware of Record’s existence, but neither was our auditor as the FY 2010 financials state that "KRS has no formal policy to limit currency risk".

The manner in which I discovered our currency manager did not add much to my confidence. It seems that very few public plans have currency managers. One notable exception is Maryland ERS which still employs Record despite a loss of $490 million in FY 2011 and has paid them over $53 million in fees.

Currency Managers need to be closely monitored. With most plans it is the staff and consultants responsibility to inform the investment committee if there are any major issues with any of our money managers. Consultants have systems set up to notify clients of any major issues with manager within days if not hours of the news, but in our case our Currency manager was kept secret from our consultant and the process broke down.In this case in October 2011 the staff should have informed the committee of Record losing a quarter of clients in three months.

Instead staff decided to keep things secret from the committee. If they had informed the committee, I would have pushed to terminate them immediately and most likely could have limited our losses by the tens of millions. Even after a major Reuters article in July 2011 which documented $400 million in outflows after poor returns the staff still kept this secret from their own board.

KRS staff admitted at the November Investment Committee that Record used leverage in their program in violation of our investment policy. Staff also disclosed to us that Record was paid over $7 million in fees by KRS over less than 3 years.

The Investment committee at Kentucky voted to fire Record and limit our losses in November 2011. I also believe that the non-disclosure of Record violated state laws that were cited in municipal bond offerings which may cause concern with the SEC. While KRS staff has chosen to release most manager changes to the investment trade press, they declined with Record.

Record has continued to have problems in January 2012 as two outlets reported continued poor performance and earnings trouble (see here and here). Reuters reported that “assets under management equivalents (AuME) fell 12 percent from the previous quarter due to loss of its second largest dynamic hedging client in November.” I believe this 2nd largest client was Kentucky, but that both Record and KRS were working hard to keep this quiet.

In April of 2012 the headline was Record shutters former flagship fund. In June the headline was “Record Currency Board takes 10% pay Cut”. Things must be pretty bad at the currency manager for this to happen.

Allowing currency managers especially those using leverage can be a disaster like it was to Kentucky and Maryland in FY 2011. I feel that public plans need to avoid expensive risky asset classes like currency management that add no apparent performance enhancement.
I thank Chris Tobe for sending me this comment and while I disagree with his conclusion, I am amazed at the lack of governance and outright attempt to hide huge losses from this currency manager.

You'll recall I already alluded to Kentucky Retirement Systems (KRS) in a previous comment of mine, Kentucky Fried Pensions, stating "something really stinks in Kentucky and it ain't grits. It's the stench of fried pensions."

Here is yet another example of terrible governance at US public pension plans leading to fast times in Pensionland. This is what happens when you have incompetent pension fund managers being supervised by incompetent board of directors who overly rely on their equally incompetent pension consultants for advice.

To be fair, in this case, it seems RV Kuhns, the investment consultant, wasn't informed of Record, but this begs the question, what exactly is the value of an investment consultant to the board if they're not grilling pension fund managers about all investments?

The governance model at most US public pension funds is terribly flawed. In this case, it was a currency manager but it could just as easily have been a Long/Short hedge fund, a fixed income arbitrage fund or whatever. When it's that easy to hide activity that leads to mammoth losses, you have to wonder what the hell is going on at these pathetic state pension funds.

A bunch of monkeys being paid monkey salaries and delivering monkey results. I would love to grill the pension fund managers who made the decision to hire Record. Where is the RFP? Who did the due diligence? Was the investment consultant aware? What were the terms of the contract? Was this a hedging mandate or an absolute return mandate? Were investment policy guidelines violated and if so, what remedial actions were taken?

I asked my former boss, Pierre Malo, now a currency manager at Perseus Capital, a Montreal global macro fund run by Jean Turmel, to weigh in on this topic:
My first reaction is that the title should read: “Beware of the disconnect between Investment committees and managers”.

In my opinion, the points reported have little to do with hiring currency managers or not. We are rather witnessing the end-result of a patent lack of communication/ understanding/experience.

Record is certainly not representative of the currency managers universe, and the lack of oversight is pathetic in my opinion.

That is the central point of this situation as I understand it.

My comments hold for any investment manager: there are good ones, bad ones and rotten ones in any asset class. Ultimately, it is the responsibility of investment committees to ensure they have the tools required to see the difference. Tools include, but are not limited to, hiring competent consultants and receiving the right information from management. Pointing solely to the investment manager and Management is a refusal to accept responsibility for your own mistakes.
Completely agree with Pierre's points above. This case just points to a gross governance gap at Kentucky Retirement Systems (KRS) and everyone is to blame, especially the board of directors.

A lot of the nonsense cited in the case above would never have happened if KRS was properly supervised, properly managed, if investment consultants did their job and if they used a managed account platform to supervise risks external managers take on daily basis (beware, just because you use a managed account, doesn't mean anything if you don't have competent staff overseeing risk limits).

Go back to read a previous comment on currency risk posted on my blog. Currency risk is underestimated by most pension funds but that doesn't mean they should ignore it or avoid currency managers. It's a tough space, I know that, but there are some excellent experienced currency managers out there with solid long-term track records (there are also others who deserve to be seeded).

Finally, Bloomberg reports the euro fell to a three-week low against the yen on speculation European Union leaders meeting for a two-day summit in Brussels will fail to agree on a strategy to solve the region’s debt crisis.

As everyone awaits to see what Germany will do, I remain confident that European leaders will finally emerge with a more solid game plan to tackle this never ending crisis. If so, risk assets and the euro will rally sharply as shorts cover their positions, leading to a solid summer rally.

Below, Nick Bennenbroek, head of currency strategy at Wells Fargo & Co., talks about the outlook for global currencies and Europe's debt crisis. He speaks with Sara Eisen and Stephanie Ruhle on Bloomberg Television's "Lunch Money." Dean Curnutt, chief executive officer of Macro Risk Advisors LLC, also speaks.

Wednesday, June 27, 2012

What Will Germany Do?

Julien Toyer and Thorsten Severin of Reuters report, Europe's leaders at odds before summit:

European leaders sound unusually divided before a high-stakes summit, with Germany's Angela Merkel saying total debt liability would not be shared in her lifetime and giving little support to Italian and Spanish pleas for immediate crisis action.

Rome and Madrid have seen their borrowing costs spiral to a level which for Spain at least would not be sustainable as it battles to recapitalize banks ravaged by a burst property bubble and cut a towering government deficit.

Spanish Prime Minister Mariano Rajoy said on Wednesday he would ask other European Union leaders to allow the bloc's bailout funds or the European Central Bank to stabilize financial markets.

Speaking in parliament before a meeting of European heads in Brussels on Thursday and Friday, Rajoy warned that Spain would not be able to finance itself indefinitely with 10-year bond yields near seven percent.

"The most urgent issue is the one of financing. We can't keep funding ourselves for a long time at the prices we're currently funding ourselves," he told parliament.

Even when there are profound disagreements, EU leaders have been burned by the markets enough times to generally make sure they sound united before major gatherings.

But divisions have been exposed by the ousting of Nicolas Sarkozy by socialist Francois Hollande as French president and the fact that Rome and Madrid have muscled into the traditional Franco-German axis.

The leaders held an unusually discordant news conference in Rome on Friday. Hollande said there must be more solidarity in Europe before countries hand over more sovereignty over their national budgets, while Merkel said she would not accept extra liabilities without overarching budget control.

The pair will have a working dinner in Paris on Thursday evening, an opportunity to repair the damage. An initial attempt to smooth over differences came at a meeting of the four countries' finance ministers late on Tuesday after which nothing was said.

In Rome, Italian Prime Minister Mario Monti said he would not simply rubber stamp conclusions at the EU summit and said he was ready to go on negotiating into Sunday evening if necessary to agree on measures to calm markets.

With Hollande's support, Monti is pushing for the euro zone's rescue funds to be used to help limit the spreads over German Bunds on bonds issued by countries that respect EU budget rules. Rajoy would settle for that or the European Central Bank doing the same job by reviving its bond-buying program.

The proposal has run into stiff opposition from Germany, the largest economy in the European Union and the bloc's effective paymaster, and has been rejected by Jens Weidmann, the powerful head of the German central bank, the Bundesbank.

Stock markets perked up last week on the hope that the 20th EU summit since the bloc's debt crisis exploded into the open in Greece would come up with dramatic measures. Investors have since thought better of that view.

European shares edged up on Wednesday and the euro was flat, with many investors out of the markets before the Brussels meeting.

"People are waiting for the inevitable - which is that policymakers will probably fail to do what is necessary," said Neil Mellor, currency analyst at Bank of New York Mellon.


Merkel stomped on the idea of mutualising debt - favored by France, Italy and Spain - at a meeting of lawmakers from her Free Democratic coalition partners in Berlin on Tuesday, according to people who attended the closed-door session.

"I don't see total debt liability as long as I live," she was quoted as saying, a day after branding the idea of euro bonds "economically wrong and counterproductive".

The words may have been carefully chosen and do not at face value rule out mutualising some portion of euro zone members' debts as the end point of a drive towards fiscal union.

Merkel find herself in a dwindling minority but holds the euro zone's purse strings and therefore nearly all the cards.

German opposition SPD leader Sigmar Gabriel told the Financial Times that urgent measures were needed to lower euro zone sovereign borrowing costs otherwise the currency bloc could "simply explode".

Italy and Spain argue that they are stretching every sinew to cut their debt mountains and need some support from their currency area peers to keep the markets at bay.

Monti won the first two of four confidence votes on Tuesday called to accelerate the passage of his labor reform that has been criticized by both by labor unions and the business establishment. The final two votes, and definitive approval, are due on Wednesday.

Spain, which has been offered loans of up to 100 billion euros to recapitalize its banks but which is determined not to ask for a sovereign bailout, is considering raising consumer, energy and property taxes.

Spanish Economy Minister Luis de Guindos said he had talked with the finance ministers of Germany, France and Italy already on Wednesday with further discussions planned.

Euro zone finance ministers will also hold a conference call on the bailout of Spanish banks and this week's request for aid from Cyprus, EU officials said. The request made Cyprus the fifth of the euro zone's 17 states to seek aid from EU rescue funds, after Greece, Ireland, Portugal and Spain.

Underlining the parlous state of Spanish finances, figures showed the central government's deficit had already reached 3.41 percent of annual gross domestic product through just the first five months of the year, close to its target for the whole year of 3.5 percent.

Spain's central bank said on Wednesday it expected recession to deepen in the second quarter of the year.

The Brussels summit is expected to agree on a growth package pushed by France worth around 130 billion euros ($162 billion) in infrastructure project bonds, reallocated regional aid funds and European Investment Bank loans.

Leaders will also discuss proposals for a banking union, but while they are likely to agree to give the ECB power to supervise big cross-border banks, Merkel is resisting any joint deposit guarantee or common bank resolution fund.

You might be asking yourself, why is Merkel resisting? John Mauldin shares some excellent insights into this very topic in his latest Outside the Box comment, What Will Germany Do?.

Mauldin begins by setting the background:

This week all eyes are on Germany, and the question is "What will Germany do?" We are going to look at four quite-short essays. Two are from GaveKal, one is from Dennis Gartman, and the last is from Kiron Sarkar – all on this very topic.

One of the reasons I really like to read the research from GaveKal is that they are very public when their analysts disagree, and you get to listen to the back and forth. Some of the best analysis I see is when Charles and Louis Gave (father and son) and Anatole Kaletsky do email battle with each other while they are on three different continents. This time it is Anatole and one of their analysts, Francois Chauchat (whom I have not had the pleasure of meeting), differing on whether Germany should (or even can!) leave the eurozone.

I should note that it is not unusual for there to be intense debates in serious research houses. Happens every day, and perhaps often during the day. When you are playing an "A"-level game at one of the best research houses, you are typically not a shy, retiring type. What is less than usual is for that debate to be played out in public for clients to see. While a strong, useful consensus may be reached, I find the sturm and drang of the debate to ofttimes be just as instructive.

Anatole thinks Germany should leave, and you find yourself nodding your head, and then you read Francois and you sit back. This is a very complicated issue.

I continue to believe that Europe in general and Germany in particular have no good choices. They can only choose between Disaster A, which is keeping the eurozone together, and Disaster B, which is breaking the eurozone apart. Either will cost trillions of euros and mean much pain. It is not a choice of pain or no pain. It is simply a decision as to what type of pain you want and in what doses you want to take it. Choose wisely.

Then Dennis Gartman weighs in this morning. For those who know Dennis, he is never shy about voicing his opinions when he writes every market day at 3 AM Eastern Time, from wherever in the world he is. But he is not married to any positions. His favorite quote seems to be from Keynes, which is (loosely), "When the facts change then so do my opinions." And then he tells everyone about the change and why. You have to love that.

But this morning he was exceptionally strong in his opening piece about Europe and Germany. After reading the notes from GaveKal, absorb Dennis's pithy analysis.

And finally there is a one-page summary note from Kiron Sarkar, which he sent me while we were exchanging emails today. (With m on my iPad 3 in Tuscany. There is an Italian company that sells a SIM card for the iPad that gives unlimited monthly data for €20. Awesome! Pay attention, AT&T).

This is a real feast for those who love to think about what's behind the headlines. I love it.
Indeed it is which is why I love reading Mauldin's comments which you can find here. Here are the comments on What Will Germany Do?:

What Will Germany Do?

By Anatole Kaletsky

Now that the Greek election is over, with the pro-bailout parties gaining enough seats for a slim majority, Europe can return to the regular cycle of panic, relief, disappointment and renewed panic, that we have observed for the past two years.

This time, however, the relief rally may be even shorter than usual, since the market's attention will soon shift from Athens to Madrid, Paris and, above all, Berlin.

Since Greece has no chance of meeting its financial targets, the new government will soon need significant new concessions from the troika. Assuming that Germany resists such concessions, as well as the much larger ones that will soon be required by Spain, the fundamental contradiction of the euro project will again be brought into focus. A single currency can only be sustained within a fiscal and political union that can mutualise and monetize the debt— something that Germany refuses even to discuss.

If this situation persists, then one of two things could happen. The debtor countries could resign themselves to permanent depression and bankruptcy as they sink further into debt traps and Greek-style crises which will ultimately push them out of the euro one by one. Or they could turn the tables on Germany. Instead of letting Germany impose its economic and political philosophy on Greece, Ireland and Portugal—and in the near future on Spain, Italy and probably France—the Club Med countries could unite and impose their economic philosophy on Germany.

With every day that passes, and especially since the French election, it is becoming clearer that the problem country for the euro—the odd man out in terms of economic structure and the chief obstacle to any political resolution of the euro crisis—is not Greece, Spain or Italy. It is Germany.

It is Germany that refuses even to talk about mutual debt and banking guarantees. It is Germany that insists on self-defeating fiscal austerity and intolerable political conditions for the debtor countries. It is Germany that vetoes quantitative easing by the ECB, which could cap bond yields and relieve deflationary debt traps. And it is Germany that makes the other euro countries uncompetitive, discourages devaluation of the euro against the dollar and refuses even to relax its own domestic fiscal policies to reduce its trade surplus and support growth.

Suppose then that Angela Merkel refuses to make any compromise on debt mutualisation or ECB monetisation when a political or market crisis next strikes one of the debtor countries, as it surely will. The obvious answer would be for the Club Med governments to point out that Germany has become the obstacle to a resolution of the euro crisis. Mrs Merkel could then be asked, one last time, to abide by majority decisions that are necessary for the survival of the euro and in the interests of all its members. If she refused to do this, Germany could be politely asked to leave. And if Mrs Merkel refused to fall in line or voluntarily leave the euro, the other countries could easily call her bluff by creating conditions that would be unacceptable to the German public. The obvious way to do this would be to force a vote in the ECB for unlimited quantitative easing to monetise government debts.

German public opinion would surely oppose this, but they could not prevent it because Germany has just two votes on the Council of the ECB —and even assuming support from Austria, Finland, the Netherlands and Slovakia, the German faction would command only 6 votes out of 23. If the two German ECB representatives were forced to resign in protest (again!), it is easy to imagine German public opinion demanding immediate withdrawal. A new Deutschemarks could rapidly be issued by the Bundesbank and, while the German banks and insurance companies would suffer large losses because of a mismatch between their euro assets and their New D-Mark liabilities, they could be readily recapitalised by a government suddenly freed of the contingent liabilities imposed by the rest of the eurozone.

This kind of euro break-up triggered by German revaluation would be much less disruptive than a "break-down" caused by devaluation in Greece or Spain. In the case of a German revaluation, there would be no contagion or capital flight, as there would be if Greece, then Spain, then Italy and France were knocked out of the euro one by one. There would be no lawsuits by disgruntled creditors.

Best of all, from both the legal and the economic standpoint, the legacy euro created by a German withdrawal would survive as a more viable common currency for the remaining countries of the eurozone. With Germany outside the euro, France, Italy and Spain could rapidly devalue their way back to competitiveness within Europe—and also internationally, by encouraging the new euro to devalue rapidly against the dollar, yen and RMB.

Without German opposition, the ECB could imitate the Fed and the Bank of England, buying bonds without limit so as to slash long-term interest rates. And if quantitative easing produced an even weaker euro or higher inflation, so much the better, since the Club Med countries have always relied on devaluation to promote export growth and inflation to eliminate debts.

A break-up of the euro caused by Germany's departure would be very bullish for practically all global risk assets, with the obvious exception of German export and bank stocks. German bonds would also suffer huge losses, since the German government could decide to repay its bonds in legacy euros, rather than redenominating all its obligations into appreciating new Deutschemarks.

For a government that had just spent hundreds of billions on recapitalising its banks for the losses they suffered in France, Spain and Italy, it would be tempting to burn foreign bondholders, rather than offering them a further currency windfall.

Germany Has To Stay: A Riposte

By Francois Chauchat

In his Reuters column last week (see here), and his recent Daily, Anatole argues that it may be more logical for Germany to leave the eurozone, rather than Spain or Italy. Germany is indeed the main outlier in economic terms; if it were removed, intra-euro zone economic dispersion would be much lower. However a scenario where Germany is the only country that exits is not just improbable—it is also undesirable:

  • Germany has long been considered by the other Europeans as the main vector of reforms, and a catalyst for change in France and Southern Europe. While Germany hardly fits the Anglo-Saxon ideal of a flexible, free-market economy (although more so since the inception of Gerhard Schroeder's reforms), the country is a more acceptable model for Europe's laggards than that provided by the US or the UK. If Germany leaves, which textbook would guide the economic policy of the South? Mao's red book? Economic history, as well as simple logic, shows that lasting growth cannot be achieved on the sole basis of devaluation and money-printing. Without supply-side and welfare state reforms, a Latin Union would have no economic viability. In this respect, we had a foretasteof how things "work" in the south when Germany was weak and busy fixing its own problems during the counter-shock years of the unification (1995-2005). The cost of capital plunged in Europe, and instead of taking this opportunity to reform their economies at a lower cost, France and Southern Europe did exactly the opposite: vested interests largely dictated stupid economic policies of social-clientelism. I do not want to see what would happen if the debt problems of these countries are fixed through devaluation and quantitative easing.
  • Politically, the consistency of any Latin Union would not be superior to that of the current eurozone. A Latin Union would be led by France. Just writing or reading this sentence, you have lost the Spaniards. Spain is a proud country, which historically sought alliances with the North againstFrance almost each time there were power redistributions in Europe. Moreover, most French and even many Italians would be extremely uncomfortable participating in a union that has lost its bad cop. If the French and others today agree, reluctantly, to pay for the Greeks, it is because they know that the Germans and the Dutch pay too! And finally, what do we make of Belgium? I doubt that even the Walloons would be enthusiastic about a Latin Union.
  • Germany would lose too much. First, its financial sector would see hundreds of billions disappear on the devaluation of the euro versus the revived Deutschemark. Most banks would thus have to be nationalized. And it would do no good to lighten its exit cost by paying its external debt in euros rather than its new currency. This would just push the DM even higher, and so German banks would lose even more on their €500bn exposure to Southern Europe, France and Belgium. In addition, the Bundesbank would have to bear an even higher cost on the unwinding of its €700bn claim on the Target2 interbank liquidity system. Indeed, when you add these two claims together, you get €1.2trn, which is more than the €1trn of German public debt held by non-resident investors. All the potential gains of keeping external debt in euros rather than denominating it in DEM would be eaten up by the losses in the banking sector. And on top of these direct losses would need to be added indirect financial losses, the economic costs of litigation, and, last but not least, the collapse of the profitability of the export industry in a country where exports accounts for 45% of GDP.
  • Most people outside continental Europe do not realize how deeply national laws, regulations and political projects are permeated with European directives. Breaking up the euro would thus be like unscrambling an omelet, and this is not just a monetary omelet. Even an exit of Germany alone would still call into question the viability of many legal, economic and political aspects of the European Union. The disruption would be considerable.
  • Finally, Germany would feel both guilty and orphaned to leave the most ambitious European project ever conceived.

Theoretically and practically, the only scenario in which a euro break-up could be done at an acceptable cost would be a clean, general and well-organized break-up where all euro members would have secretly pre-agreed on the terms, and that would keep the project of European integration alive (see An Alternative Euro End Game [subscribers only]). The probability of this ideal scenario is, unfortunately, not much higher than the one we have just discussed.

Ill News

By Dennis Gartman

Concerning the EUR, the week begins with some ill news, as the "troika" officials that were to visit Athens have chosen to "postpone" their meeting scheduled for today with the new Greek government. Further, it appears that when the pan-European Summit meeting begins later this week (and the debate in the media and in TGL for the next several days shall be about this impending meeting, rest assured of that), any hopes that Ms. Merkel will accede to the demands of Mr. Hollande that more financing be made available and for the advent of EUR-bonds will be dashed. Hollande has been pushing, for example, that the EUR-zone's bailout funds be allowed to buy sovereign debt on the secondary market, without having to invoke so-called "emergency borrowing procedures." Mr. Hollande wants the ECB to have the day-to-day ability to buy such debt as is necessary; Ms. Merkel is openly opposed to even considering such action. To this point, Ms. Merkel won't even debate it, much less move to allow it, leaving Mr. Hollande rather openly ... and embarrassingly ... flailing in the economic and political wind. As one anonymous French economist at a leading French bank said over the weekend,

"There is a real conflict here and the future of Europe is at stake. Mr. Hollande has exerted the maximum pressure on Merkel but if she remains intransigent and only agrees to the growth pact, I believe he will cave in and give her wants she wants."

What Ms. Merkel wants is nothing short of German oversight and ultimately dominion over all future sovereign debt issuance, oversight of the European banks themselves, and German supremacy on nearly all fronts economic and political. In Ms. Merkel's world ... and here she is merely reflecting the general philosophy of the German people themselves ... if Germany's checkbook is going to be relied upon, then German oversight shall be demanded by the German government, as demanded by the German people.

We found it interesting and exemplary of the problems attendant to Europe when, at a meeting last week of Merkel, Hollande, Monti, and Rajoy, Ms. Merkel sat on one side of the table, faced by the French, Italian, and Spanish prime ministers on the other.

One side has the "gold," the other side has the debts and, as is always the case, he who has the "gold" has the power. Even Tony Montana understood that simple fact when he said, in his famous soliloquy in Scarface,that "In this country, you gotta' make the money first. Then when you get the money, you get the power. Then when you get the power, then you get the women." In Europe, we've come to this: Germany has the money and it has the power and that, simply, is that.

Germany's finance minister, Mr. Schaeuble, was busy over the weekend ahead of the meetings he will be attending later this week, appearing on television and speaking with the press. He said in an interview with the German TV network ZDF that Greece simply hasn't done enough to make good on promises regarding fiscal austerity and meeting certain debt/GDP ratios that it made in exchange for bailout funds. Mr. Schaeuble said that the process goes far deeper and that the root causes of Greece's problems have to be resolved. He said,

"We have to fight the causes.... [and] anyone who believes that money alone or bailouts or any other solutions, or monetary policy at the ECB – that will never resolve the problem. The causes have to be resolved.

"It's not going to help to take money to it. The decisive thing is to credibly fight the causes of the crisis. It's succeeding very well in Ireland and Portugal. It's not succeeding very well in Greece. But it must succeed in Greece. There's no other way to do this.

"Greece hasn't tried enough so far, that has to be said quite clearly. That has to be said with respect for the domestic political difficulties. But no one on earth who has followed this issue would think that Greece has fulfilled what it has promised ... [however] Italy and Spain are different on this question. They're making great reform efforts."

At this point we should remember that Mr. Schaeuble has played, is playing, and in the future shall play the "bad cop" in the usual "good cop/bad cop" tandems that so often develop in situations like this. Ms. Merkel ofttimes looks to be the "good cop" in relation to Schaeuble.

Mr. Soros is "bad copping" this morning, too, as he has made it clear in one press conference after another in the past several days that he believes Europe is truly at risk of collapsing unless something material and timely is done to allow the ECB to buy pan-European debt in the open market. He has called upon Europe's leaders to swiftly create a "European Fiscal Authority" that would have the ability and the authority to buy Italian and Spanish debt, but only following actions by the Italian and Spanish governments to achieve credible material budget cuts. Mr. Soros has said that unless this authority is created and announced before the impending European Summit ... which begins on the 28th, by the way ... the result "could be fatal" for the EUR. Ms. Merkel has made it clear that she is not willing to agree to such a proposal until such time as full fiscal union is established; and that, as we understand it, would require major changes to Maastricht and the other treaties that are at the very heart of "Europe" as we know it presently.

And finally, this note from Kiron Sarkar, who I think is in Ireland today:

In addition to the existing monetary union, the Germans want fiscal union, leading to political union – in that order.

Political Union is the clear goal. They understand that the EU (and not even Germany), cannot compete with emerging countries such as China, India or developed countries such the US, in the future, given their natural strengths, without a political union. In addition, they do not want any more EU fudges, fixes or compromises, so common within the EU in the past.

Germany also understands that the EU/EZ, as currently structured, is flawed and that Europe needs true political union. Indeed, the Germans are increasingly suspicious of the EU bureaucracy, as they believe it is a bloated, overpaid and incompetent organisation – totally true and very much the views of the UK, for a very long time. The EU leaders were previously selected by EU heads of state on the basis that there were the least effective (and therefore would pose the least problem to them), so why should anyone be surprised. Why did the Germans take so long to understand you could well ask.

The Germans (Mrs Merkel) are prepared to open up their cheque book (though you must understand that it is not unlimited), but only if they believe that EZ countries will stick to pre agreed fiscal targets ie their money will make a difference. France, designed the EU to suit itself, but essentially it created an intergovernmental club, rather than a supranational organisation as today's WSJ very rightly says. In addition, the French ensured that they "parked" their people in the senior most positions possible.

The French, on the other hand, do not want to transfer sovereignty to another organisation, but, in my view, will have to. They are relatively weak and getting weaker. President Hollande's promises are unaffordable. Just today, the French minister of finance admitted that France needs to find between E7bn to E12bn of savings to reach its agreed budget target this year. How can Hollande's wild (and expensive) promises be accommodated. They cant. However, the French are known to take to the streets, which could make this issue explosive. Unlike Sarkozy, Hollande at the end of the day, will give in, though the domestic political pressure he will face will be enormous. Changes to the French constitution, which will be necessary if there is to be political union, will be particularly difficult. Most of the other EZ countries will be more amenable.

Mrs Merkel is facing increasing anti EU/EZ pressure at home– the only good news is that her main opposition is very much more pro EU/EZ. For her to act like the "Iron Lady" will play well with the voters in Germany – not a minor issue for politician who is seeking reelection in late 2013.

In regards to Gartman's comments above, a friend of mine shared this with me:

Although I have much respect for Mr. Gartman, I disagree with a few things that he said.

First, there is one myth that needs to be put into context. Germany's financial strength is based on economies of scale not only on the competitiveness of the individual German worker.

There are many countries that have equally competitive workforces but are nowhere near as successful as Germany at generating wealth.

So where do the economies of scale come from? Exports or, more specifically, access to foreign markets.

If Germany loses access to foreign markets either by being alienated from the rest of Europe or having to sell in Euro and manufacture in Deutschmarks, their "pot of gold" will quickly evaporate.

In addition to the above, I direct your attention to an excellent comment written by Patrick Artus of Natixis, What kind of economy would the euro zone be without Germany?. Artus concludes:

The euro zone excluding Germany is characterised, as a whole, by:
  • competitiveness and foreign trade problems;
  • low potential growth;
  • low corporate profitability;
  • Public finances in a bad state.
If the euro zone were to become a federal monetary union, with solidarity between countries and pooling of certain investments (recapitalisation of banks, for example) and risks, could the situation of the euro zone excluding Germany be anything other than:
  • benefiting from transfers from Germany;
  • benefiting from Germany's credibility in the markets;
  • benefiting from Germany's guarantee;
or could it share this burden with Germany? Probably, the burden on Germany would be very heavy.
I've already weighed in on this important topic. Let me be clear: Germany is screwed either way but in the end, Frau Merkel will cave to demands on eurobonds and fiscal union, not because her European counterparts are asking her to, but because the bond market will crack her like a Chinese fortune cookie.

It's time that Germany puts an end to its illusions. Yes, Germany is footing the bill for this eurozone mess but they benefited the most from this imperfect union. Schnell, Frau Merkel, your time is up. If you continue dithering, you will sink the eurozone and rest of the world, ensuring a protracted period of nasty global deflation (not the benign kind the Japanese experienced).

Below, Marc Lasry, Managing Partner and founder at Avenue Capital management, talks with Bloomberg's Stephanie Ruhle about the buying opportunities in Europe if you invest on a long-term basis. He speaks on Bloomberg Television's "Market Makers."

And renowned academic David Harvey asks if it is time to look beyond capitalism towards a new social order that would allow us to live within a system that really could be responsible, just, and humane (h/t, Sam Noumoff). It's two years old but brilliant. Nothing like a Marxist to expose the deficiencies of capitalism (unfortunately, they have no real long-term remedies).

Tuesday, June 26, 2012

Will New Rules Roil US Public Pension Funds?

Lisa Lambert and Nanette Byrnes of Reuters report, New rules may make public pensions appear weaker:

New accounting rules approved on Monday are likely to show public pension funds are in a weaker financial position than previously thought and intensify disputes over how public retirement systems are funded.

The Governmental Accounting Standards Board, which sets the accounting standards for the public sector, finalized a single system of accounting to replace the menu of financial reporting options public pension funds currently use.

State and local governments will have to post their net pension liability - the difference between the projected benefit payments and the assets set aside to cover those payments - up front on financial statements, under the changes.

"The pension liability will appear on the face of the financial statements for the first time. That's going to create the appearance of a weaker financial position," said Robert H. Attmore, GASB chairman, who said the board intended to "peel back the veil so things are more transparent and there's more information for policy makers."

Governments participating in multi-employer plans - essentially smaller cities that are part of the state systems - will have to represent their share of liabilities, which could also make them appear financially weaker. Currently, they only have to state how much they have contributed.

Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management, said GASB was headed in the right direction in terms of comparability and transparency, adding that some of the changes will sharply increase deficits for some governments.

"It shouldn't immediately cause anyone to file for bankruptcy," he said, adding that "it may immediately raise the level of attention to seriously do something here."

The biggest GASB change affects how the pension funds project rates of return on their investments, which provide 60 percent of their revenue. Underfunded pensions would have to lower their estimates for returns.

GASB also eliminated a process known as "smoothing," where the pension systems spread the liabilities over time, making the funds more reactive to volatility in financial markets. Funds can still spread out expenses, but over a shorter time frame.

Some of the GASB changes go into effect on June 2013, with the others implemented in June 2014.

More changes are coming. Starting next month, GASB will begin work on accounting for other retiree benefits, mainly healthcare, which tend to be in worse shape than pensions.

Some critics say the reforms could distort perceptions of governments' and retirement systems' health. They worry politicians will seize on the new, larger liabilities, to push through policy changes or starve employee retirement systems.

"We're concerned about confusion of the numbers," said Keith Brainard, research director of the National Association of State Retirement Administrators. "If a plan has a liability of $4 billion, does that mean they need $4 billion today? No. It's an accounting number."

Governments typically provide about 20 percent of pension fund revenue, but under the new standards, they will not have to disclose their annually required contributions (ARC). Ciccarone, however, raised concerns that governments would no longer post this information.

The Government Accountability Office, the nonpartisan federal auditor, reported in March that "most state and local government plans currently have assets sufficient to cover their benefit commitment for a decade or more."

Still, skepticism has risen about both the long and short-term prospects of public pensions. A week ago the Pew Center on the States estimated states are short $757 billion to pay retiree pension benefits, and the total could grow.


Although it sounds like a technical accounting move, the new standard on rates of return is key to the pension wars.

Pension funds that are considered adequately funded could continue forecasting investment returns in-line with their historic averages, usually around 8 percent, under the new GASB rules. The board would only define those pension systems as having sufficient assets on hand to pay the pension of current employees and retirees, but did not set a funding ratio.

Funds lacking sufficient cash to cover benefits must lower their projected investment rate to about 3 percent to 4 percent. Specifically, the investment rate would have to match "a yield or index rate on tax-exempt 20-year, AA-or-higher rated municipal bonds," an information sheet on the changes said. On Monday, the yield for AA-rated municipal bonds due in 20 years was 3.12 percent, according to Municipal Market Data.

When investments fail to meet the forecasts, governments - essentially taxpayers - and employees must pitch in money to fill the void. At the depth of the recession in 2008, the return on pension investments fell by 25 percent, Pew found.

The new rules offer a compromise. U.S. Congress would like systems to use a rate they call "riskless," about 4 percent. Pensions counter they should use historical averages.

Pew found that Wisconsin is the best-funded retirement system in the country, and Illinois the worst.

"States like New York, which are making their contributions to their pension plans and are well-funded, their liability should not be affected by the new discount rates," said David Draine, senior researcher at Pew, about the GASB changes. "States like Illinois that are having trouble making their contributions, you would expect to be more affected."

According to a study by the Center for Retirement Research at Boston College, the funding ratio which is at 76 percent in 2010 could decline to 57 percent with the new accounting rules.

In some cases the reductions expected in the funding ratios are massive. Illinois teachers, a notoriously underfunded pension fund, currently has a funding ratio of 48.4 percent. Under the GASB's proposed changes it may fall to as low as 18.8 percent.

Pew also found states are short $627 billion for other retiree benefits, and 17 states have set aside no funds for them. According to Pew, states currently have only 5 percent of what they need for these "Other Post-Employment Benefits."

Until 2006, GASB did not have any accounting standards for those benefits.

I've already covered the pathetic state of state pension funds. I applaud these new GASB rules because they increase transparency at state and local pension funds, which in turn should make them a hell of a lot more accountable.

Is there a risk that some politicians will jump on the opportunity to attack public pension funds, looking to dismantle them? Of course there is which is why unions and public pension funds should fight back with their own campaign, making the case for boosting public pensions.

But the biggest problem with public pensions funds in the United States lies with a governance model that breeds corruption and mediocrity. When I wrote that ATP and APG are years ahead of most US public pensions, I meant it. The same can be said of large Canadian public pension funds which are global trendsetters.

Are Dutch, Danish and Canadian public pension funds perfect? Of course not. I can raise several issues with all these funds, even the best of them. But when I compare their overall health to that of their US counterparts, I conclude that the overriding factor explaining their success lies with their superior governance model which focuses on accountability, transparency and alignment of interests.

Having said this, in order to get the governance right in the US, they need sweeping political change. Importantly, they need to create independent investment boards that operate at arms-length from state and local governments. Fat chance that this will ever happen, especially in the US where fast times in Pensionland means everyone wants a slice of the pension pie.

Below, as more and more states struggle to keep their pension promises, a new Pew study painted a stark picture of just how big the budget hole has become in some states. PBS News Hour's Jeffrey Brown discusses the pension gap with the Pew Center's Kil Huh and Northwestern University's Joshua Rauh.

Finally, speaking of new rules, embedded a clip from Bill Maher's latest show. While pension shortfalls aren't funny, Bill Maher is, and even though I don't always agree with him, he offers great comedy relief. Below, his latest "New Rules". Priceless.

Monday, June 25, 2012

Will Euro Dithering Lead to Global Deflation?

Stocks slid in early trading on Wall Street Monday, following global markets lower, after Spain requested help for its struggling banks. Bloomberg reports Treasuries rise as Soros warns Euro is at risk:
Treasuries rose, extending a quarterly gain, as investors sought refuge amid speculation European leaders will fail to make progress at a two-day summit on stemming the euro bloc’s debt crisis.

Longer-term bonds extended their advance after a report that Moody’s Investors Service plans to downgrade Spanish banks. German Chancellor Angela Merkel rejected joint euro-area bonds or bills, saying that introducing shared debt in the 17-nation currency region now would be “counterproductive.” The U.S. will auction $99 billion of notes this week.

“The market is stepping back from any meaningful expectation for anything from the summit,” said Ian Lyngen, a government-bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “We are back in a risk-off mode until there is a reason not to be.”

The 10-year note yield fell six basis points, or 0.06 percentage point, to 1.61 percent at 10:45 a.m. New York time, according to Bloomberg Bond Trader prices. The 1.75 percent note due in May 2022 advanced 18/32, or $5.63 per $1,000 face amount, to 101 1/4. The 30-year bond yield dropped eight basis points to 2.69 percent.

Treasuries remained higher even after sales of new homes in the U.S. increased in May more than forecast, rising 7.6 percent to a 369,000 annual rate. A Bloomberg News survey projected a rate of 347,000.

Ten-year yields have fallen 60 basis points this quarter and have lost 26 basis points this year.

Expensive Securities

A valuation measure showed the benchmark notes trading at almost the most expensive level ever. The term premium, a model created by economists at the Federal Reserve, was at negative 0.86 percent, after reaching a record negative 0.94 percent June 1 as investors sought refuge from Europe’s debt turmoil.

A negative reading indicates investors are willing to accept yields below what’s considered fair value. The average over the past decade is 0.50 percent.

German 10-year bunds, the euro area’s benchmark government securities, also gained today as investors sought safety, with the yield dropping 12 basis points to 1.46 percent.

Demand for the safest assets has helped Treasuries beat all other U.S. fixed-income securities for the first time in three quarters.

Bond Returns

U.S. government debt has returned 2.9 percent since March, while corporate bonds returned 1.9 percent, mortgages rose 1 percent and municipal bonds increased 1.8 percent, according to Bank of America Merrill Lynch index data. The combination of Europe’s debt crisis, China’s slowdown and record stimulus by the Fed means Treasuries are outperforming the global bond market by 1.3 percentage points, after lagging behind by 2.4 percentage points in the previous quarter.

Treasury yields extended declines after the newspaper Expansion reported Moody ’s plans to downgrade Spanish banks by two or three levels today. The Spanish paper, citing an executive at a bank it didn’t name, reported the statement may come at around 11 p.m. in Madrid. An official at Moody’s couldn’t immediately comment on the report.

European leaders open their summit June 28 in Brussels. Germany’s Merkel said in a speech in Berlin today that the goal is a political union in Europe with stronger oversight. Proposals for joint euro-area bonds or bills and joint deposit insurance are “wrong and counterproductive,” she said.

‘Risk Off’

“It’s the risk-off trade again,” said Justin Lederer, an interest-rate strategist at Cantor Fitzgerald LP in New York, one of 21 the primary dealers that trade with the Fed. “We go back and forth with concerns out of Europe. People want to be optimistic, but there’s just so much uncertainty.”

The billionaire investor George Soros said yesterday Europe should start a fund to purchase the bonds of Italy and Spain in return for budget cuts in the nations. European leaders are running out of time to show investors they will do what’s necessary to save their currency, he said in an interview in London with Bloomberg Television’s Francine Lacqua.

“There is a disagreement on the fiscal side,” Soros said. “Unless that is resolved in the next three days, then I am afraid the summit could turn out to be a fiasco.”

The Treasury will sell $35 billion of two-year debt tomorrow, the same amount of five-year securities the next day and $29 billion of seven-year notes on June 28.

Operation Twist

The Fed plans to sell as much as $8.75 billion today of Treasuries due in March to October 2014 as part of its Operation Twist program to cap borrowing costs, according to the Fed Bank of New York’s website.

Central-bank officials led by Chairman Ben S. Bernanke last week extended the program, which is replacing $400 billion of shorter maturities with longer-term debt through the end of this month, until year-end. They increased it by $267 billion.

The difference between yields on 10- and 30-year Treasuries shrank to 107 basis points, from 109 on June 22. The spread has narrowed from this year’s high of 1.23 percentage points in May, known as a flattening of the yield curve.

“We believe it is not yet fully reflecting the demands shock from a six-month extension of Operation Twist, implying that the curve has room to flatten,” Anshul Pradhan and Vivek Shukla, analysts at the primary dealer Barclays Plc in New York.

The spread between 10- and 30-year yields is testing resistance at the 200-day moving average at 108 basis points, according to data compiled by Bloomberg. A break below that may mean a move toward the June 5 low at 103 basis points, the data show. Resistance refers to an area on a chart where technical analysts anticipate orders to sell a security to be clustered.

Another week dominated by news coming out of another Euro summit. It's quite depressing watching European leaders dither while Rome burns. In my last comment on treating life as an experiment, I mentioned rumors of a 2 trillion euro bailout bazooka, but also cautioned Germans are increasingly weary of bailing out their southern neighbors.

Erik Kirschbaum of Reuters reports, Schaeuble says "no" to throwing money at euro crisis:

Throwing more money at the eurozone debt crisis will not solve the problem because the troubles have to be resolved at the cause, German Finance Minister Wolfgang Schaeuble said on Sunday.

Schaeuble also said in an interview with German TV network ZDF that Greece has not done enough to fulfill promises it made in exchange for bailout funds. Schaeuble also criticized the recent interventions by U.S. President Barack Obama.

"We have to fight the causes," Schaeuble said. "Anyone who believes that money alone or bailouts or any other solutions, or monetary policy at the ECB -- that will never resolve the problem. The causes have to be resolved."

Schaeuble added: "It's not going to help to take money to it. The decisive thing is to credibly fight the causes of the crisis. It's succeeding very well in Ireland and Portugal. It's not succeeding very well in Greece. But it must succeed in Greece. There's no other way to do this."

Schaeuble said Greece has clearly not done enough.

"Greece hasn't tried enough so far, that has to be said quite clearly," Schaeuble said. "That has to be said with respect for the domestic political difficulties. But no one on earth who has followed this issue would think that Greece has fulfilled what it has promised.

"Italy and Spain are different on this question," he added. "They're making great reform efforts."

Schaeuble dismissed advice from U.S. President Barack Obama, who has called on Europe to do more to fight the crisis.

"Mr. Obama should focus on reducing the American deficit," Schaeuble said. "It's higher than in the euro zone. You have to understand that people are always ready to give others advice quickly. Our argument is 'we're ready' (to do more). We want more Europe."

As I stated in my last comment, Schaeuble is right that Greece hasn't done enough to rein in the bloated public sector, but he also fails to mention the Greek bailout is nothing more than a corporate handout to German banks and companies.

A friend of mine shared these insights:

Schaeuble is somewhat disingenuous. It takes two to tango in a default, borrowers and lenders.

The bailout loans to Greece were actually bailout loans to the French and European banks who had extended way too much credit and did not have strong enough balance sheets to support a default. In effect, the bailout transferred a large proportion of the risk from the banks to the EU, IMF and ECB.

Once enough of the risk was transferred from the balance sheets of the French and German banks and their balance sheets were strong enough to absorb a haircut, the troika forced a “voluntary” haircut on the remaining private sector debt.

End result is Greece has been a pawn in a larger game. They are stuck with a large amount of sovereign loans rather than private sector debt. Why is this important? Historically, there are no haircuts on sovereign loans only renegotiation of the terms (i.e. lengthening of tenor and lowering of interest rates).

The only way for Greece to gain the upper hand is to generate a primary surplus. Once this is achieved and the country is no longer dependent on debt to fund their day-to-day obligations, they will be in a better negotiating position to execute an orderly restructuring of all their debt with favourable terms which is sustainable in the long term.

Unfortunately, it's not the austerity measures that is the ongoing problem in Greece. It is how they have been implemented. Wherever possible, the government consistently favoured applying measures onto the private sector creating a scenario whereby government revenues have been falling faster than expenses and the primary deficit remains intact.

I sometimes wonder if the French and German governments were fully cognizant that the Greek government would continue to do what they had done in the past. This minimized the damage to France, Germany, and the rest of Europe (even if it increased the hardship on Greece).

Unfortunately, we have no one else to blame but ourselves. Greece had its fate in its own hands over the last three years and no one stepped up.

The only hope now is to position the country at some point to generate a primary surplus. I am not hopeful. The first announcements made by our newly minted government just continues along the same political appeasement path ... the civil service will not be touched.

Anyway, not a good start. At least, the country is not in a full meltdown which is what would have happened if Syriza was in power.
And my uncle in Greece, a self-employed businessman, shared this with me:
Greece is applying strict austerity measures, it is already in deep recession and the GNP has dropped last two years about 20%. The unemployment is over 21 %.

It is true that measures taken are not enough due to the reaction of some populist-demagogues politicians and also syndicates.

On the other hand political instability and two general elections during last two months have caused some delays.

Let us hope after the creation of a new pro-European coalition government things will move faster.
One can only hope as Bloomberg reports Greece
may have to wait at least another five years before it can sell bonds to investors, according to financial institutions that trade debt with European governments.

But the power and fate of the global economy lies in Berlin, and if Germany doesn't quickly abandon its illusions, and growth policies aren't implemented on a global scale, you can bet that the next big trend is deflation:
The world is awash in debt that probably can't be repaid, leading many investors to fret that central banks will one day soon come to the rescue by easing the plight of borrowers through a massive amount of money printing, in effect inflating the debt away.

Worries about just such an outcome have led many investors to believe that the current, debt-driven economic crisis will most likely be resolved through inflation, engineered by central banks. Having more inflation would make the debts easier to service and less onerous. It's the argument gold bugs often make when they claim fiat currencies are doomed and everyone should have a stash of bullion, along with a gun and a supply of canned goods.

But Comstock Partners, a U.S. money manager, says forget about an inflationary resolution to the debt problem. The most likely next big trend, in their view, is deflation, or falling price levels. They believe deleveraging, or the elimination of debt either through repayment or bankruptcy, will lead to deflation.

"We have long maintained that a debt bubble followed by a credit crisis leads to a deflationary recession or depression, and a major secular bear market," the firm said in a recent letter to clients. "In our view, it is the overwhelming force of the debt deleveraging that has overcome government efforts to inflate."

While deflation hasn't happened yet in Canada, it might be getting close. The May CPI numbers reported today showed consumer prices fell 0.2 per cent from April and were up a mere 1.2 per cent over the past year. Japan has been experiencing deflation for years, and Switzerland has been starting to experience falling consumer prices as well.

Comstock's report makes an interesting observation. So far, governments and monetary authorities have tried nearly every trick they have to jump start the global economy, but it hasn't worked.

There have been massive deficits, two rounds of quantitative easing, or money printing, by the Federal Reserve Board and just this week it announced an extension of Operation Twist, another Treasury bond purchase program. In the U.S., the Fed has tripled the monetary base, without leading to runaway money supply growth or much economic growth, for that matter. Something is working against the efforts by policy makers.

Comstock thinks it has the answer: people are trying to get out of debt (witness the fall in household debt in the U.S. to 84 per cent of GDP recently, from its peak of 98 per cent in 2008).

If consumers are using their money to repay debt then they're not buying things, so the demand for goods is weak, so businesses have little reason to hire or make capital expenditures. This sets up a vicious circle of weak demand that starts to feed on itself and is difficult to arrest. Deleveraging still has a long way to go for household debt to even fall back to the 55 per cent of GDP average over the past 60 years.

"Under these circumstances, we believe that inflation cannot take hold in the real world. Businesses feel minimal pressure from rising wages and have no compelling need to raise prices. Even if they tried, consumers would not have enough income to pay the higher prices and would resist, forcing producers to rescind whatever price increases they try to put through," Comstock says.

You can read Comstock Partners' special deflation report here. Before you dismiss it, think about why bond yields are continuously going lower. The world is awash of debt and the risk of policy mistakes (ie. focus on mindless austerity) risks throwing us into a multi-decade deflationary depression.

Below, George Soros speaks to Bloomberg's Francine Lacqua ahead of the EU summit to give his blueprint for the eurozone. Also embedded clips Yahoo interviews. One with Gluskin Sheff's chief economist and strategist David Rosenberg who claims 'modern-day depression is here' and Jerry Webman, Chief Economist at Oppenheimer Funds, who says don't count on consumers to save struggling economy.

Sunday, June 24, 2012

How to Treat Life as an Experiment?

It's St-Jean Baptiste Day, a national holiday here in Quebec, so decided to run through some interesting stories I've been tracking over the weekend. Remember to follow me on Twitter (@PensionPulse) where I post links to stories on pensions, markets, health, Greece and a lot more.
  • Muslim Brotherhood’s Morsi wins Egyptian presidential vote: The Globe and Mail reports that Egypt’s election commission has declared Mohammed Morsi of the Muslim Brotherhood the winner of Egypt’s first free elections by a narrow margin over Ahmed Shafiq, the last prime minister under deposed leader Hosni Mubarak. Egypt remains deep divided and it remains to be seen how these tensions between Christians, Muslims and the secular army play out under this new government.
  • Schaeuble tells Greece to "stick it": Reuters reports that German Finance Minister Wolfgang Schaeuble said Greece's new government should stop asking for more help and instead move quickly to enact reform measures agreed to in return for previous bailouts from its European partners. Schaeuble is disingenuous because the Greek bailout is nothing more than a corporate handout to German banks and companies. But German frustration is running high and with good reason. To my disgust, the first thing the new Greek coalition government did upon forming a new government was reassure the ridiculously bloated public sector that there will be no new cuts. A friend of mine with vast experience working in Greece said it perfectly: "If there is civil war in Greece, it will be between the public and private sector. They are asking two thirds of the population who have borne the harsh cuts of austerity to keep paying the entitlements of one third. Greece should follow France's example and privatize large parts of their public sector."
  • Europeans preparing a 2 trillion euro bailout bazooka?: Business Insider quotes Jeff Sault, Chief investment Strategist at Raymond James, sharing a rumor that he has heard about an enormous bailout program for the beleaguered eurozone, to the tune of 2 trillion euros. Sounds like another big band-aid to me.
  • Should active managers panic?: You bet. According to CNBC, nearly two thousand fund managers gathered in Chicago this past week to talk strategy in a tough market - and an industry-wide rift. Most are underperforming their indexes. These are tough times for active managers struggling with euro woes and rigged markets.
  • Grantham on bonds, potash and Las Vegas: One active manager I track closely when peering into top funds' quarterly activity is Jeremy Grantham. Business Insider quoted him as saying bonds are disgusting, potash is in crisis and it's time to obliterate Las Vegas. Amen!
  • Are women better leaders?: Yes, the results are in and women are better leaders. No surprise to me. Having worked in finance, seen firsthand how big swinging dicks with inflated egos are terrible leaders because all they care about is their image and lust for power (read this article on 7 Habits of Extraordinary Teams) . But as the Atlantic article Why Women Still Can't Have It All states, if women are going to benefit from a true level playing field, there is a lot that needs to be changed. Having said this, I like what George Will said on ABC This Week's roundtable: "Got news for you. Men can't have it all either. That's life, deal with it." Another comment I liked was from Major Garrett whose mom was a successful corporate executive: "The big difference is she used to go to work at 8:30 and leave at 4:30. Nowadays, it's a 15 hour workday."
  • Why half of America hates their job: CNBC reports that Americans are quitting their jobs on their own volition because they are seeking more personal fulfillment in their workplace lives.This isn't an American phenomena. Most people everywhere are miserable at work, getting squeezed to work longer hours for less pay. Not surprisingly, more and more people have become disenchanted with corporate life as it is. Many feel trapped and unappreciated and they long to do something that has significance and value, something by which they can make a difference in the world. Big wake-up call to corporations seeking to retain talent.
  • Failure in Rio: Alexander Cockburn wrote an excellent comment in Counterpunch discussing the failure in Rio. According to Mr. Cockburn, the conference twenty years on from the huge Earth Summit, Rio 92, has been unable to produce even the pretense of an energetic verbal commitment of the world’s community to “sustainable principles.” Agreed, these conferences have always been pretty fraudulent affairs. No wonder Greenpeace has declared war on the finance sector.
  • Dr. Michael Bury's UCLA commencement speech: Kudos to Zero Hedge for posting this speech by Dr. Burry who was featured in Michael Lewis' book, "The Big Short". Embedded it below. Do not agree with everything the good doctor warns of, especially when comparing US debt to that of Greece or any other nation, but he raises some excellent points on finance, the nexus of power, and the culture of self-entitlement. The advice he gives graduating students is priceless, even better than that of the late Steve Jobs.
  • Altucher on treating life as an experiment: James Atucher wrote another classic comment on how to treat life as an experiment. He interviewed interviewed four prostitutes, drug dealers, criminals, potential dates (for him), and homeless kids every single week for three years and offers some exceptional insight. You should also read this priceless advice from a homeless man turned millionaire. Also, read Altucher's latest on how multi-tasking can kill you.
  • The multiple sclerosis controversy: The media is all over the news that Ozzy Osbourne's son, Jack Osbourne, was diagnosed with MS. Not surprisingly, coverage has been pitiful, full of stereotypes of how poor Jack will end up in a wheelchair (majority of MS patients never end up in a wheelchair, and that was before drug therapy exploded). What disgusts me was how he lost a job after revealing his diagnosis, prompting the LA Times to state that going public with MS is ill-advised. Rubbish! Take it from me, someone who has battled MS for over 15 years, silence of any illness, not just MS, can kill you inside. The only way to fight stereotypes -- and there are plenty of ignorant fools out there -- is to expose them.

And on that note, invite you to watch some clips below, including one from Fox Business reporter Neil Cavuto, an MS patient who came out in the open, on why Ann Romney doesn't need your sympathy. Also embedded Dr. Burry's UCLA economics commencement speech and a clip of a relapsing remitting MS patient, David Oliver, sharing his story of recovery and hope following adult stem cell therapy at the Stem Cell Institute in Panama City, Panama.

Must caution you, while I'm glad I underwent the 'Liberation treatment' in Albany, New York, I'm very skeptical of any clinic in Panama claiming to cure or treat MS and many other diseases using adult stem cells. Most of these outfits are run by quacks looking to profit off of desperate patients. If you have MS, focus on these five things and be skeptical of everyone, including neurologists. Basically, listen to your body and do what is right for you (watch Ann Romney below).